You are here

Market real gold, not paper gold

Section: Daily Dispatches

11p EDT Monday, July 12, 1999

Dear Friend of GATA and Gold:

I have the privilege to share with you tonight,
courtesy of, some
economic analysis as brilliant as anything I've ever

The author of the following two essays, Reg Howe,
offers a new and compelling explanation of the war
against gold that is nevertheless reassuring, since it
validates gold's enduring monetary function even as
we're being told that gold is becoming merely
another commodity.

I have a feeling that we will be referring to Howe's
analysis for some time. It will remain posted as
Message No. 161 at the GATA egroup web site,

Please post this as seems useful.

With good wishes.

Gold Anti-Trust Action Committee Inc.

* * *


July 11, 1999

By Reg Howe

Salut a tous: Congratulations on a most interesting web
site, especially for us old fogies who still think of
gold as money. In the spirit of Le Cafe (desole de ne
pas avoir un clavier Francais), I would like to venture
some observations and invite comment by those more
knowledgeable than I.

Several years ago in an essay on gold (quot;The Golden
Sextantquot;), I pointed out that gold is arbitraged like
currencies, which is to say on the basis of interest
rate differentials. Currencies with higher interest
rates are always in backwardation against those with
lower rates. As of that time, gold had never been in
backwardation against any currency because gold LIBOR
(or the gold quot;leasequot; rate, as it is usually termed) had
never been above the interest rates on any currency.
And for good reason: Gold had always been considered
the soundest money and therefore had always carried the
lowest interest rate structure.

Today yen interest rates are lower than gold lease
rates. Accordingly, gold is in backwardation against
the yen. This backwardation may be seen indirectly by
multiplying forward gold prices on the Comex times like
maturity forward yen prices against the dollar. It may
be seen directly on the Tokyo Commodities Exchange
(TOCOM) (, where at July 7 spot gold
was quoted at Y1009/gram, and June 2000 gold at Y992.

This situation invites the following trade. Sell gold
in New York for dollars; put the proceeds in U.S.
Treasury notes at 5 percent; and buy the same amount of
gold forward in Yen at a lower effective dollar price.
Even if the yen exposure is hedged (probably
unnecessay), the cost of the hedge is unlikely to
exceed 3 percent, which is the amount by which the
Treasury rate (approximately 5 percent) exceeds the
gold lease rate (approximately 2 percent).

In other words, a holder of gold today can maintain his
long gold position (on paper at least) while earning
more than twice the gold lease rate. Under these
conditions, it is not surprising to find most of the
open interest on the Comex in the nearby months (the
sellers?) and most of the open interest on the TOCOM in
the further out months (the buyers?). For those
interested in short positions, it appears that total
open interest on the TOCOM is some 470,000 1-kilo
contracts against warehouse stocks of less than 10,000

While nothing is certain, in the event of a dollar
decline, the odds of a loss on the forward yen
exceeding a gain on the forward gold appears slight.

Why do I say this? Because I believe that the
underlying manipulation affecting gold today is the yen
interest rate.

The notion that the yen is actually a sounder money
than gold, and thus deserving of a lower interest rate
structure, strikes me as ludicrous given the state of
Japan's economy, banking system, and government
finances. Rather, I am of the view that today's yen
interest rates are an artifice of the current
international monetary system and represent a desperate
attempt by the world's central bankers to bail out the
Japanese economy before its problems engulf us all.

Otherwise, it is to me unfathomable why any central
banker would hold his country's reserves in yen at
current yields rather than in gold.

Again, I offer these comments in the spirit of true
cafe conversation, and should you deem them worthy of
posting, would be quite pleased to receive intelligent
reaction or rebuttal. Bonne chance.

* * *

By Reg Howe

Another way to view gold's backwardation in yen on the
TOCOM is as payment or incentive to Japanese citizens
(and others) to defer the urge to convert yen to gold.

Suppose I am Japanese. I earn my living in yen, keep my
savings in yen, and think in yen. With yen interest
rates at only half a percent and viewing the banking
and economic problems in my country, I begin to think
of converting some yen savings to gold. But when I
check the prices on the TOCOM, I discover that I will
pay less for gold to be delivered to me next summer
than today, and can keep earning my measily half a
percent in the interim. As of July 9 gold for July 1999
delivery was Y1015/gram, and for June 2000 delivery
Y997. Looks like a pretty good deal, at least as long
as I can trust the TOCOM to make good on delivery next

Judging by the TOCOM's historical volume figures, a lot
of people are beginning to think along these lines.
Volume for June exceeded 1.8 million gold contracts,
almost twice any preceding month. Volume for the first
half of 1999 exceeded 7 million contracts, putting this
year on track to break the 1994 annual volume record of
almost 12.5 million contracts.

No historical figures for open interest or warehouse
stocks are available, but warehouse receipts at the end
of May covered less than 9,000 gold contracts. As of
July 8 open interest was more than 480,000 contracts,
and the net short position of TOCOM members was 87,500
contracts -- that is 87.5 tons, of which almost 52 tons
were represented by Mitsui and more than 14 tons by

At $260/oz., 87.5 metric tons of gold equates to well
over $700 million.

The TOCOM's blurb on quot;market credibilityquot; claims it has
over $400 million for customer insurance against
defaults by its members. So if you can trust Mitsui and
Sumitomo to deliver the gold next June, hold on to your
yen and go for the half-percent interest and the 1.8
percent discount, which, not coincidentally, total
approximately the gold lease rate. After all, what you
are effectively doing is loaning to the market the gold
that you otherwise would have bought today. Indeed, the
TOCOM is really doing nothing more than running a huge
gold loan by its customers.

What many used to trading commodities often don't
appreciate is that in the currency and gold markets,
exchange rates (the dollar gold price being an exchange
rate) are set at spot. Future exchange rates are simply
the product of interest rates (the gold lease rate
being an interest rate) and arbitrage.

Suppose I have $100. It earns interest at 5 percent,
and a year from now I have $105.

Suppose I have Y100. It earns interest at half a
percent, and a year from now I have Y100.5. So if today
$1 buys Y120, I can choose now between having $105 next
year or Y12060, if I convert my $100 to yen and invest
the Y12000 at half a percent.

This calculation suggests that one year from now, if
$105 equals Y12060, the exchange rate should be about
$1 to Y114.85. Accordingly, if I wanted today to buy a
one year forward contract for yen against the dollar, I
would expect to get a rate around this level, which is
in fact quite close to that currently quoted.

On the other hand, if I want to buy oil or copper or
orange juice one year forward, I have no interest rate
to use, and without looking up the prices, I do not
even know if they will be in contango or backwardation.

Put another way, all the judgments that go into setting
futures prices in commodities are distilled in the
interest rates for currencies and gold.

The difference between currencies and gold is not that
gold is a commodity but that gold is a money whose
supply -- though large -- is not infinite.

The Fed will never run out of dollars; the Bank of
Japan will never run out of yen. But both, and all the
central banks together, CAN run out of gold.

All the talk today about gold being quot;demonetizedquot; is as
off the mark as the notion that governments quot;gave gold
its valuequot; under the gold standard. Gold gave the
currencies that were linked to it their value depending
upon the credibility of the link. And today gold is
slowly revealing the bankruptcy of Japan.

My guess is that if we had figures for the private or
invisible gold market such as we have for the TOCOM, we
would see a similar picture writ much larger.

Much of what GATA alleges, if true, supports this view.
My only disagreement with GATA goes not to the
likelihood that governments and central banks are
taking actions designed to support the shorts in the
gold market, but to the underlying reasons for their

In my view, they are not engaged in some petty
corruption for the benefit of favored bankers or even
in an effort to somehow demonetize or tarnish gold.
They are being forced to mobilize their gold to support
a yen interest rate that is below the gold lease rate.

They are, as I have tried to point out, effectively
bribing people to hold yen today by offering discounted
gold in the future. And they are doing this, I believe,
because they have run out of options to stave off
financial collapse in Japan.

Finally, I should add a word about the gold mining

Larry Parks ( has done a good job pointing
out that these companies do not appear to understand
their product. They think that they are selling the raw
material for jewelry, not money.

To my way of thinking, rather than writing letters to
British Prime Minister Tony Blair, the gold mining
companies should be promoting currency exchange boards,
except the money to which the link should be made is
not the currency of some big power but gold.

Any country willing to accept the discipline of a true
currency board, like that in Argentina, can just as
easily accept the discipline of a gold standard. They
are effectively the same system except for one very
important difference: Under a currency board you take
the interest rates of the reference currency, but under
the gold standard you get the interest rates
historically associated with gold -- that is, the gold
lease rate.

And if you really want to bust the shorts, you get
China, Taiwan, and Hong Kong to begin considering a
common currency based on gold. What better way to
further the integration of Hong Kong's economy with
mainland China's, to draw investment capital to China,
and to begin in a peaceful manner the reunification of
China and Taiwan?

Why these three central banks with their huge hoards of
U.S. Treasuries want to keep financing a consumption
boom in the United States is beyond me. But if I were a
G-7 central banker, je pourrais te dire mon pire
cauchemar. C'est pas Japon. Bonne fin de semaine (oops,
une expression Quebecoise, pas un intello, moi). A


------------------------------------------------------------------------ home: a href=